CARD Act Conference: Key findings

FEB 22, 2011

Summary of key findings in the presentations to the CFPB CARD Act Conference

On Feb. 22, 2011, the Consumer Financial Protection Bureau held a conference on the credit card marketplace one year after the effective date of many of the provisions of the Credit Card Accountability Responsibility and Disclosure Act (“CARD Act”).

The data from the eight presentations at the CARD Act conference provide an overview of the credit card market – the cost of credit for consumers, the supply of and demand for credit, and industry profitability. The CFPB also released data on the day of the CARD Act conference that focused on the ways that specific industry practices addressed in the Act – such as interest rate hikes and overlimit and late fees – have changed and impacted the consumer credit card experience.

Cost of credit for consumers

When a consumer opens a new credit card account, the consumer is told what the Annual Percentage Rate (APR) or interest rate will be for purchases and what the APR will be for other types of transactions such as cash advances. Prior to the CARD Act there was a wide gap between the stated interest rate and the actual cost of the card to the consumer over time. In large part that was due to “penalty” interest rates that, prior to the CARD Act, could be triggered if, for example, the consumer was one day late in making a payment or went over her credit limit by one dollar. Those penalty interest rates were typically applied to existing balances as well as new purchases. In addition, in the pre-CARD Act world, penalty fees added significantly to the cost of a credit card.

The CARD Act curtailed certain practices in the credit card industry that were neither fair nor transparent to consumers and created unanticipated costs. The result has been to make credit card pricing more transparent, so that upfront interest rates now more accurately reflect the true cost of the credit card. While front-end pricing has increased, the overall cost of credit has not. The effective interest rate paid by consumers did not increase and is no higher today than it was in 2007 or 2008.

In 2009, the average APR on all mature accounts (adjusted to reflect the drop in the prime rate) increased by 2.4 percentage points from 2008. The average APR offered in new mail solicitations also increased in 2009 by 2.6 percentage points over the same time period. Multiple factors contributed to this increase, and the precise weight of each factor cannot be determined from the currently available data. (Argus; Mintel)

Looking at actual interest charged (i.e., excluding those who pay no interest), the actual average interest rate that consumers paid in the third quarter of 2010 was 12.3 percent, which was below the level in the comparable period in 2007. (Argus)

Similarly, the total amount of revenue (including both interest and fees paid by consumers and interchange fees paid by merchants) averaged 17.8 percent of total credit card balances in Q3 2010, below its level in any of the prior three years. (Argus)

Industry profitability

Industry income as a percentage of balances increased in 2010 over pre-CARD Act levels. Industry profitably improved as well, reflecting primarily the reduction in loss rates as the economy has improved, which in turn enabled card issuers to release some of the reserves they had created for expected bad debt. Specifically:

In 2008, the top card issuers’ net revenue before losses was 8.8 percent of total credit card balances. In 2010, the same card issuers earned 9.2 percent before losses. (Credit Suisse)

In 2008, loss expenses (including changes in bad debt reserves) were 7.5 percent resulting in pretax income of 1.2 percent of total credit card balances. In 2010 loss expenses were 5.8 percent resulting in pretax income of 3.4 percent. (Credit Suisse)

Financial services companies generally classify customers into different market segments based on their credit scores and other factors. The definitions differ from issuer to issuer, but generally they are grouped into the above categories, from most to least credit worthy.

† Also referred to as “near prime”

* Midprime and subprime together are “nonprime.”

The supply of and demand for credit

In 2007, before the recession started, card issuers were heavily marketing credit cards to acquire new customers. A significant percentage of the new accounts that they opened were for consumers with lower credit scores (i.e., midprime and subprime borrowers). During the recession of 2008 and 2009, card issuers substantially curtailed their marketing and raised their credit standards, approving a much smaller percentage of non-prime consumers.

In 2010, that trend turned around. Credit card marketing expanded and credit standards were relaxed, although the level of marketing has still not returned to pre-recession levels and credit standards are tighter than they were before the recession began.

Specifically:

More consumers are being offered credit cards now than in 2009. The total number of mail solicitations more than doubled between Q4 2009 and Q4 2010 and the percentage of consumers who were offered a credit card increased throughout 2010, with the largest increase occurring within the midprime segment. (Mintel Comperemedia)

Credit is increasingly available to consumers with lower credit scores. The percentage of overall new accounts represented by midprime and subprime consumers doubled between 2009 and 2010, from 13 percent to 26 percent. By way of comparison, in 2007 – before the start of the recession – 39 percent of new accounts came from these segments. (Argus)

The total dollar amount of credit available is starting to increase. The average credit line granted to new cardholders increased in 2010 for each risk segment. Average credit lines for new accounts were equal to 2007 levels for all consumer segments except for those with the very highest credit scores, which decreased slightly. (Experian)

While the overall cost of credit has remained constant, overall credit use has decreased. The total amount of credit card debt declined in 2009 and again in 2010, with a cumulative decline of 15 percent. The average bankcard debt per cardholder declined from roughly $3,500 in 2007 to approximately $2,750 in 2010. The decrease was the result of both higher levels of “chargeoffs” – debt that card issuers write off as uncollectible – compared to 2007 and lower new balances than in 2007. The decrease was concentrated in the near prime and subprime segments. (Argus; TransUnion)